Home >Money >Personal-finance >A little bit of risk can help achieve your financial goals

If you are staying away from investing, as many people do, for the fear of risk, you may actually be putting your financial situation and goals at risk. Holding all your savings in a savings bank account—which is today’s equivalent of putting money under the pillow—may eliminate the risk of losing the absolute value of the principal, but the low returns that your money will earn will mean two things: one, you aren’t able to accumulate the corpus; and two, you will lose the real value of the amount invested. 

If you trade some degree of safety for higher returns, you will be able to protect your goals in the long run. Here are a few ways in which you can balance investment risks.

Divide and invest to beat inflation

Inflation is the invisible risk that you have to deal with even as you protect your investments from volatility or default. But products that provide the comfort of safety and liquidity tend to offer low returns. If the returns are lower than inflation, it means that your money is losing purchasing power. The longer you hold your money in such products, the greater is the loss in value. Here’s an example. If your savings bank account earns an interest of 3.5% per annum and the inflation rate is 4%, then 10,000 in the savings account would have a real value of only 9,529 a decade later. 

The solution is obviously to earn higher returns that not only negates the impact of inflation but also helps your portfolio grow in value over time. The efficient way to do this is to look at your future money needs through a time lens and demarcate your holdings according to when you need to use the funds. So, set your goals and decide when they have to be achieved.

Hold only what you need immediately, including the first tranche of emergency funds, in products that are highly liquid and have negligible risk of volatility or default. Such products include savings bank accounts and money market schemes. 

The investments earmarked for goals a little farther away should be held in products where the returns are higher. Trade off some benefits of liquidity and convenience of easy withdrawal for better returns for this segment of the portfolio. Products that meet these specifications include short-term fixed deposits, short-term plans and fixed maturity plans of mutual funds, and debt products whose maturity is aligned to when the funds are required for the goals. 

For the portion of your portfolio that you intend to use only well in the future, you can look at higher-return products in equity and debt. Such products face short-term fluctuations in value and restrictions on liquidity (if you want to get the best out of them), which makes them unsuitable for short-term needs.  

By demarcating your portfolio on the basis of when you require the funds, you are not only protecting your portfolio from the risk of inflation from low returns but also ensuring that it is able to fund the goals as and when they arise. 

Let time iron out fluctuations

Many investors see fluctuation in the value of an investment as the most visible sign of risk. The volatility in price means that the realised value of the investment may be lower than the amount invested. Volatility is the market’s response to factors that affect the investment, be it equity, debt securities, real estate, gold, or anything else. If the investment is fundamentally sound, then the good news will outpace the bad, and over time propel the value to a much higher level than the acquisition price. But for this to happen, you need time on your side. For investments earmarked for goals in the future, interim volatility should not concern you and your focus should be on where the price will go given the fundamental strengths of the investment. Fluctuation in price is an issue when the funds invested are required in the immediate future and you may have to sell at a loss. 

To reduce the risk of volatility as a barrier to investment, earmark investments in equity and other volatile assets for long-term goals. Protect the appreciation in the investments by redeeming the funds and moving to products with stable returns as the goals come closer.

The volatility in the prices of long-term debt securities from changes in interest rates in the market can be dealt with by holding the security to maturity. The risk of losing value in the bonds is a concern only if the bond is sold or redeemed before maturity. If you hold the bond to maturity you get the full amount as contracted on redemption. To implement this strategy effectively, align the tenor of the bonds to that of the goals. The goals must have at least as much time as the tenor of the bond so that it does not become necessary to sell at a loss before maturity. 

Keep your financial goals in sight

A situation that many face is finding themselves unable to meet goals not because they have not saved or invested but because their investments are tied up in assets that do not support their goals. They may need income to meet some regular expense, say, the college fees of their children, but find that their money is tied up in equity or Public Provident Fund or another investment that doesn’t generate regular income. Or, the money is invested in bonds that pay periodic interest but the corpus is required only well in the future.

If the interest received is not invested immediately, it will affect the final corpus that is accumulated. This mismatch between the goals’ need for liquidity, income or growth and the assets in which the money can be avoided by keeping the goal in focus while selecting the investment.

Selecting and managing investments in line with the goals will help rationalise the risks.

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